Among the many impacts of COVID-19, non-essential Canadian workers have been forced to quickly adapt to working from home. Given the current circumstances, taxpayers may be wondering if any home office expenses can be claimed on their tax returns. As we explain below, taxpayers cannot deduct as many expenses as one may otherwise think since the federal Income Tax Act (the "ITA") sets out certain rules and prescribes deductions available to salaried employees, commission employees and self-employed persons. Historically, the Canada Revenue Agency (the "CRA") has restrictively interpreted the provisions of the ITA dealing with home office expenses, however, it is hoped that the CRA will revisit its position due to the effects of COVID-19.
General Limitation on Deduction of Home Office Expenses
Taxpayers generally cannot claim deductions in respect of home office expenses unless expressly permitted by the ITA. The ITA sets out an additional limitation for claiming deductions of home office expenses, namely that the home office must either be:
- the principal place (more than 50% of the time) where the individual conducts business; or
- used exclusively for the purpose of earning income from business and used on a regular and continuous basis for meeting clients, customers or patients in respect of the business.
Taxpayers may find it more difficult to meet the requirements of the second subsection above, especially given the uncertainty of what constitutes a "meeting". The longstanding administrative position of the CRA is that a "meeting" must involve two or more persons in the same place, despite case law which suggests that a telephone call constitutes a meeting for those purposes. Given changing business practices and the rise in virtual meetings, we query whether the CRA will revisit its interpretation of "meeting" in the same way that it changed its position on taxable reimbursements for computer equipment purchased during COVID-19. Read more on this here.
An employee must also prepare and file a Form T777 – Statement of Employment Expenses and cause their employer to complete and sign a Form T2200 - Declaration of Conditions of Employment, certifying that the employee is required to pay their own expenses while carrying out the duties of employment and such expenses are not reimbursed by the employer.
A salaried employee who is paid a fixed salary by his or her employer may only deduct prescribed expenses contained in paragraph 8(1)(i) of the ITA, which include:
- electricity, heat and water;
- maintenance and repairs;
- rent in respect of real property; and
- other expenses consumed directly in the performance of the duties of employment, such as certain supplies.
A commission employee who is paid a commission in whole or in combination with fixed pay is only permitted to deduct certain prescribed expenses contained in paragraph 8(1)(f) of the ITA, which include home insurance and property taxes in addition to the enumerated list of allowable expenses for salaried employees.
Limitation on Amount Deductible in a Year
The amount of expenses claimed must be proportionate with the usage of the home office using a reasonable approach. For instance, one may deduct the percentage of rent that relates to the home office based on the square footage of the office in relation to the square footage of the entire home.
Employees may not use home office expenses to increase or create a loss from employment in a year, but expenses in excess of employment income can be carried forward and deducted in a subsequent year.
Self-employed persons include those who conduct business as sole proprietors or as partners in a partnership. Provided that the tests described are satisfied, a self-employed person can generally deduct home office expenses to the extent that they are incurred for the purpose of earning income from a business, including deductions for mortgage interest and capital cost allowance ("CCA"). As such, eligible home office expense deductions for self-employed persons are not limited to an enumerated list.
However, it may not be beneficial for a self-employed homeowner to claim CCA if the home office is based out of their principal residence, as doing so will trigger a deemed disposition of the portion of the home used for the office. Consequently, the principal residence exemption will not be available for the home office when the home is eventually sold and the homeowner will be required to report a capital gain, if applicable, on such portion of the home.
A self-employed homeowner may still use a home office and claim related expenses without losing the principal residence exemption provided that:
- they do not claim CCA;
- there is no structural change to the property in respect of the home office; and
- the home office is ancillary to the main use of the property as a residence.
Limitation on Amount Deductible in a Year
The amount of home office expenses that a self-employed person may deduct in a given year is capped at the net income from the business before any deductions for home office expenses. Excess expenses can be carried over to the immediately subsequent year provided the person remains eligible for such deductions. The practical implication of this restriction is that home office expenses cannot be used to increase or create a business loss.
For any given year, a self-employed person may deduct the lesser of the following amounts:
- any amount carried over from the previous year, plus the home office expenses incurred in the current year; and
- the amount of net income (or loss) after adjustments.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.